Taxes and Economic Growth

If TELs and STVRs are effective in reducing tax burdens, do they help a state economically? The evidence indicates they do. A literature review by Scott Drenkard and Joseph Henchman of the nonprofit, Washington, D.C.-based Tax Foundation,[33] concluded that taxes are very important to a state’s economy, and the authors refer to “the cohesion of recent literature around the conclusion that taxes matter a great deal to business.”[34] They also observe that with regard to business decisions, “Every change to a state’s tax system makes its business tax climate more or less competitive compared to other states and makes the state more or less attractive to business.”[35]

In a 2008 study of the economic effects of state income taxes, Barry Poulson and Jules Gordon Kaplan begin with the following summary: “A number of studies have explored the impact of taxes on state economic growth. Most, but not all, of these studies find evidence of a negative effect of taxes on various measures of state economic performance.”[36] In a 2006 study, W. Robert Reed examined the relationship between state taxes and economic growth in the continental United States. His analysis, using data from 1970 and through 1999, provided “evidence of a negative and statistically significant relationship between taxes and economic growth.”[37] Specifically, Reed reports, “A state having a tax burden that is one percentage point higher than other states is estimated to have real [per-capita personal income] growth that is lower by 0.90 percent in subsequent five-year periods.”[38]

Steven Deller and Judith Stallmann looked for a link specifically between TELs and state economic growth in their 2006 study, “Tax Expenditure Limitations and Economic Growth.” They used 1987 to 2004 data from all 50 states and searched for “patterns in annual growth of per capita income.”[39] The authors found that TELs adopted before 1987 (such as Michigan’s Headlee Amendment) are associated with a “1.93 percent higher growth rate in per capita income” than states without TELs.[40] The TELs passed after 1987 also showed higher growth rates than states without TELs, but at an average annual rate only 0.63 percent higher.[*],[41]

[*] It is worth noting that the authors also found that limits imposed on local governments “may actually hinder economic growth.” Deller and Stallmann, “Tax and Expenditure Limitations and Economic Growth,” (Marquette Law Review, 2006), 536, http://goo.gl/PL4iX (accessed Oct. 22, 2012).